What Doesn’t Kill You Makes You Riskier : the Impacts of CBDC on Banking Stability

We provide normative analysis of the impact of central bank digital currency (CBDC) on banking stability. Each customer has a different level of financial intelligence, which determines both her surplus from CBDC and her ability to monitor risk-taking behavior of a bank she deposits to. As the surplus from CBDC increases, more consumers switch from bank money to CBDC as the primary means of payments, downsizing the bank’s balance sheet. We find that the bank takes on excessive risks, thereby causing financial instability, if and only if depositors’ baseline surplus from CBDC is neither too high nor too low